Oracle Done With Sun. Are Chips Next?

Oracle (NASDAQ:ORCL) last week reported a strong quarter that beat analyst estimates. Increased spending on cloud computing by companies in many industries has been beneficial to Oracle, which entered the more difficult server business with its acquisition of Sun. Let’s take a closer look.

Oracle’s $7.4 billion Sun acquisition has been integrated successfully, and the company is expected to exceed its $1.5 billion operating profit target. Following its foray into hardware with the acquisition, Oracle is now looking to acquire more hardware companies, especially in the area of chips.

Aaron Ricadela and Ian King on Reuters report that Oracle is looking to purchase semiconductor companies and makers of industry-specific software. In an annual investor meeting last year, CEO Larry Ellison said that he wants to follow the approach of Apple CEO Steve Jobs by owning more of the intellectual property that underpins computer chips. Apple acquired semiconductor company PA Semi for $278 million and now designs its chips for its iPhones and iPads. Doug Freedman, an analyst at Gleacher & Co. in San Francisco, said that Oracle may buy a semiconductor company with technology for servers, and three potential targets are AMD, IBM’s chip division, and NVIDIA.

Some reports say Mellanox Technologies could be another possible candidate. Rick Merritt, an editor at EETimes, says:

”Mellanox is a distant possibility. The megatrend in servers is to sell servers, networking and storage as a bundle. Sun is relatively weak in networking compared to HP and IBM. If Oracle acquires any chip companies, I suspect they would be in 10G+ Ethernet. A more likely [acquisition] scenario would be Aquantia who like Teranetics (bought by PLX) is a standalone 10GBase-T PHY company that has raised $100 million and not shown profitability yet. A wild card might be SeaMicro, that Atom-based low power multiprocessing server startup that debuted this year. I would not expect Oracle needs a fab.’’

Mark LaPedus, the semiconductor editor of EE Times, adds

“I can’t see Oracle buying AMD or ARM. That makes no sense. I also don’t see Oracle building a fab. However, I could see Oracle investing or buying a company with expertise in the ARM world. Oracle/Sun may want an ARM-based server one day. I can see Oracle investing in startup Smooth-Stone Inc.. The ARM-based chip server startup has recently raised $48 million from a  syndicate of investors, including ARM, Advanced Technology Investment Co. (ATIC) and Texas Instruments Inc.”

Acquiring SeaMicro may be something along the lines of Apple’s PA Semi acquisition, but acquiring any of the larger chip companies is a terrible idea. Oracle hasn’t yet made any chip acquisitions , but last month it announced the acquisition of select intellectual property assets of Ndevr that adds environmental reporting and business intelligence capabilities to Oracle’s ERP Solutions. Ndevr’s environmental solutions can be used to track emissions and other environmental data against reduction targets. This acquisition is part of Oracle’s ongoing commitment to provide best-in-class solutions for environmental compliance and efficiency, delivered as part of the intrinsic business processes of the organization.

Oracle’s Financials
Oracle, with annual revenue of $26.8 billion, reported third-quarter revenue of $8.8 billion, up 37%. Net income was up 78% to $2.1 billion or $0.41 per share. Non-GAAP EPS was up 40% to $0.54 versus analyst estimates of $0.50 on revenue of $8.67 billion.

During the quarter, Oracle bought back 7.9 million shares for $250 million and ended the quarter with $24.3 billion in cash and investments. It also raised its dividend to $0.06 per share from $0.05 per share.

In the third quarter, new software license revenue, an indicator of future revenue, increased 29% to $2.2 billion. Technology new license revenue was $1.6 billion, up 7%. Applications new license revenue was $639 million, up 34%. Software license updates and product support revenue was $3.8 billion, up 13%. Services revenue was $1.1 billion, up 23%.

Revenue from hardware systems products was $1.0 billion, while revenue from hardware system support was $656 million. Gross margins from the hardware unit were 55% and the overall operating margin was 44%, about the same level as last year.

For the fourth quarter, Oracle expects revenue to grow 10% to 14% and GAAP EPS to be $0.56 to $0.60. Non-GAAP EPS is expected to be $0.69 to $0.73 versus analyst estimates of $0.47 on revenue growth of 30% to $8.4 billion. New software license revenue growth is expected to range from 9% to 19%. Hardware product revenue growth is expected to range from 6% to 12%.

Oracle said all its employees in Japan are safe and its building in Tokyo is essentially undamaged. It does not expect material impact in the fourth quarter from the tsunami, earthquake, and nuclear crisis in Japan. The stock is trading around $32.64 with market cap of about $165 billion. It hit a 52-week high of $33.71 on February 18.

I have to say that I’d much rather see Oracle acquire Informatica and other software companies in the SaaS space where the company’s presence is limited than see it dabble in chips. Sounds like an altogether bad idea to me.